A New Approach to Estimating Portfolio-Balance Models of the Yield Curve

Antonio Diez de los Rios

Staff Working Papers from Bank of Canada

Abstract: We show that the parameters of a broad class of portfolio-balance models can be recovered from estimates of Gaussian dynamic term structure models (GDTSMs) using a two-step estimator that bypasses the fixed-point problem that characterizes portfolio balance models. Specifically, we develop a novel canonical representation of bond supply in terms of factor-mimicking portfolios, whose returns replicate the structural shocks to the pricing factors. We identify these structural shocks by assuming that each shock corresponds to a distinct, mutually exclusive dimension of bond-supply variation. Using U.S. Treasury yields and macroeconomic data, we show the recovered shocks admit interpretations as hedging-risk-premium, risk-bearing-capacity, and monetary policy shocks.

Keywords: Financial markets and funds management; Funds management; Models and tools; Econometric, statistical and computational methods (search for similar items in EconPapers)
JEL-codes: E E4 E43 E44 G G1 G12 H H6 H63 (search for similar items in EconPapers)
Pages: 108
Date: 2026-09
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:26-33

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